Australia has proved resilient through so many economic shocks that it has almost come to be seen as unbreakable. Therefore, if even Australia is wobbling then we know things are getting serious. But that appears to be precisely what is happening: rather than being the outlier, the country is sharing the all-too-familiar global issue of rising interest rates (from slightly over zero up to 3.1 percent in the space of nine months) and inflation (up to a 32-year high of 7.3 percent by the end of last year).

As a worsening economic scenario brings pressure to bear on the corporate world, it is beginning to present opportunities in Australia’s nascent special situations market for fund managers such as Sydney-based Arbitrium Capital Partners. The firm, which was launched in September 2020 and currently has around A$231 million ($164 million; €150 million) in assets under management, focuses on three areas: opportunistic credit, stressed situations and distressed credit in Australia and neighbouring New Zealand.

As financing needs increase, companies are finding their traditional banking allies not quite so keen to take their calls. “Most of the traditional banks in Australia have tightened their lending criteria,” says Mukhtader Mohammed, Arbitrium co-founder and managing director. “We’ve been seeing a gradual decline over the last 20 years in banks participating in corporate lending, and our research suggests the major banks now have around 63 percent household lending versus 37 percent corporate lending on their books. That creates a good space for private credit.”

That gap in the market encouraged Mohammed and fellow co-founder Daniel Liptak to launch Arbitrium, despite private credit being a nascent asset class in Australia, which only dates back to around 2015. Mohammed was previously a restructuring expert at Deloitte, a role that enabled him to observe the evolution of an asset class largely focused on real estate, where the dominant positions were held by overseas managers rather than local fund managers.

“We’ve found corporates which have been on this cheap money for quite some time and with economic conditions softening, their financial performance is being impacted”

Mukhtader Mohammed, Arbitrium Capital Partners

But despite humble roots, it was clear a big opportunity set was growing – particularly in the stressed arena. “The reason for starting Arbitrium was I just couldn’t see anyone doing mid-market corporate restructuring,” says Mohammed. “The larger funds have always been there for deal sizes above A$100 million; anything less than A$20 million there are family offices that are getting sophisticated and looking after that part of the market, but in the A$20 million-A$100 million bracket, there was no one really doing that.

“From our research into corporate lending across Australia and New Zealand, we think there’s probably about $100 billion of corporate loans. Of those, it’s hard to put a number on how many are in the high-risk category but mortgage stress is increasing in the housing market and you can make certain assumptions on the corporate side based on that.”
He adds that Bloomberg data shows distressed debt of around $650 billion globally, with a large jump over the last 12 months.

Immature market

“The Australian corporate credit market, I would say, is still relatively immature when compared with the US, Europe and Asian corporate credit markets so, from an Arbitrium perspective, we feel starting out in 2020 was possibly a very good time to get first-mover advantage,” says Mohammed. “There aren’t many local funds that specialise in special situations and actively go out and look for non-investment grade stressed or distressed senior secured loans with a returns-enhancing instrument.”

Arbitrium’s triple-pronged approach

1. Opportunistic
Growth financing that does not meet the credit metrics for a traditional bank, such as a business that is expanding too fast and does not have much in the way of operating profits. The financing could be needed for a particular asset or for an acquisition or merger, but it is mainly primary issuance in the opportunistic space.

2. Stressed
Mostly in the secondary space where a corporate has an incumbent bank but has experienced a change in its financial position that has seen performance and valuation drop, and it is at risk of breaching its covenants.

3. Distressed
Where value is broken and the business is probably in a formal process of administration or receivership. Mohammed says his background is more in the stressed/distressed space as he comes from an insolvency background, but the Arbitrium team has a mix of private equity, direct lending and stressed/distressed backgrounds.

The sense of increasing opportunity tallies with what Arbitrium has been experiencing on the ground, particularly in the secondaries market over the last six months. Mohammed says the firm has reviewed more than 40 deals over the last two and a half years, with a total size of around A$1.4 billion, of which it has deployed or committed A$110 million into three transactions. The firm has a minimum deal ticket of A$20 million and will go up to A$80 million, or as high as A$100 million in some circumstances.

Mohammed describes what a typical opportunity today looks like: “We’ve found corporates which have been on this cheap money for quite some time and with economic conditions softening, their financial performance is being impacted. Some are very close to taking up all their covenant headroom and even just starting to breach it.”

In terms of sectors, Arbitrium is primarily interested in areas with strong collateral backing such as manufacturing, agriculture, food, infrastructure and building products. “We think there will be more stress, distress or opportunism in those sectors that could make them attractive for us to look at,” says Mohammed.

The firm is also keen on companies with exposure to large growth markets such as China, which is finally opening up after covid and freeing up supply chain blockages, and India, which signed a free trade agreement with Australia at the end of last year and has bucked global trends by growing strongly. “Any sector that has an exposure to India and China is going to be a growth story and could be part of our turnaround strategy,” says Mohammed.